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While mutual funds offer the benefit of easy liquidity, redeeming them before you have met your financial goals can dent your financial planning. Loan Against Mutual Funds (LAMF) is a lucrative alternative that can be availed from Banks and Non-Banking Finance Companies (NBFCs).This type of loan is like an overdraft facility where you are charged interest only on the withdrawals made. While this loan is great for those trying to avert a temporary financial crisis, businesses can use this to raise capital for an upcoming expense or investment.
How to Apply for Loan Against Mutual Fund?
The procedure is the same as the service provided by the bank accounts for an overdraft. By approaching any NBFC (non-bank financial company) or bank, you can avail a loan against hybrid or equity mutual funds. You must submit the mutual fund units as security for the bank's debt to acknowledge your loan request.Once you have applied, the lender will look at the quality of your holdings before granting the loan. However, make sure you check the lender's approved list of mutual funds against which you can avail a loan. Here are a few things to know;
- Tenure of the Loan: Up to 1 Year
- Minimum Loan Amount: 25 Lakhs
- Loan To Value (LTV) Ratio: Up to 50% of the current market value of your holdings
- Collateral: Lien on Mutual Funds
What is Lien on Mutual Funds?
Before carrying on with using the loan, knowing the lien on mutual funds is vital. Lien is a file that enables the bank to hold or sell the fund. Thus, when you sign a statement on behalf of the bank, you allocate the fund units' rights that you own to the bank.To do this, you have to get in touch with the fund house and inquire in the bank's name for a lien on your holdings. In case of joint holdings, all unit owners should sign the application correspondence for lien change.
Loan Against Mutual Funds Application Process
Here is how you can apply for a loan against Mutual Fund:
- Choose a lender that is best suited to your needs.
- Then fill in the form and provide all necessary details such as your mutual fund folio number, name of the scheme, the total number of units available, and their value. You can do this online also by filling the requisite details.
- The documents are then sent to the mutual funds' registrar. They evaluate the filings and mark the lien against the total number of units that have been put forth as the collateral.
- The processed form is then sent back to the bank, and the borrower informing them about the lien marked.
Remember that once your mutual fund units are earmarked for the lien, they are not available for redeeming. Only when you have entirely repaid the loan amount can you again claim the units.
Benefits of Loan against Mutual Funds
- Low-Interest Loans: Being a secured loan, the interest rate on loan against mutual funds is lesser compared to other unsecured loans. Moreover, since they are a low tenure loan, this can be a great alternative to personal loans.
- Take Loan Against Irredeemable Funds: Some mutual funds such as ELSS come with 3-year mandatory lock-in. Thus, you cannot redeem them before this period is completed. However, a loan against such funds can be a great way to utilise them to raise capital.
- Keep Your Assets Secured: Investors do not require to cash the mutual fund units for loans against it. The units are pledged as collateral for loans but are not sold, and investors can get loans without losing the possession. If there is an urgency for money, it is better not to sell the units but avail a loan against it.
- Avail Long Term Capital Gains Benefits: Both equity and debt funds enjoy taxation benefits if held for a longer-term. Redeeming them before 1 year (in case of equity funds) and 3 years (in case of debt funds) can cause you to lose money to taxes. Loans against them, however, will let you enjoy the tax benefits while helping you raise funds.
- Low Credit Score Requirements: Since collateral backs the loan, the credit score requirements are not as stringent as in some other types of loans.
- Continue Earning from the Mutual Fund: While you can't redeem the funds till you repay the loan amount, it can continue to earn for you. Depending on the type of fund you hold, you can get these earnings in the form of dividends or the same is reinvested to give you compounded growth.
How to Remove the Lien?
Once you have repaid the amount, the lender will send a request to the fund house requesting removal of lien on the holdings. Some lenders may also allow partial removal of lien based on the loan amount repaid. The units on which lien is removed are called free units which can be redeemed by you.However, the lender can reinforce the lien if the individual fails to pay back the loan in the period agreed. The same goes for defaulters as well. In this state, the lender asks for the mutual fund to cash in the units earmarked and mail the cheque to the lender for repayment towards the loan amount.
Choose a Reliable Lender
In case there is a shortage of funds, or there is an essential need for a large sum of money that may not be available with you, this loan can be the right option. However, it is essential to choose a reliable lender with good terms and the loan interest rate.
FAQS - FREQUENTLY ASKED QUESTIONS
How does a loan against mutual funds work ?
Investors start investing in mutual funds with an objective in mind. If the individual needs any funds at any time, one of their options of choice is to liquidate their investments. This usually causes a disruption to their investment objective. To avoid that from happening, most banks and NBFCs offer to give the investor a kind of a personal loan against the mutual fund investment.
A loan against mutual funds is a type of loan where you pledge your mutual fund units as collateral to borrow money from a bank or a financial institution. The loan amount is usually a percentage of the total value of your mutual fund units that you pledge as collateral.
During the loan repayment period, you will have to pay interest on the loan amount, which is calculated based on the prevailing interest rates and the loan tenure. The interest rate for a loan against mutual funds is typically lower than that for a personal loan, as the mutual fund units provide a secure collateral for the lender.
If you are unable to repay the loan on time, the lender may sell off a part or all of the mutual fund units pledged as collateral to recover the outstanding loan amount. It's important to note that this may result in a loss of value for your mutual fund investments and impact your long-term financial goals.
What is the interest rate of a mutual fund loan ?
In a general sense, the interest for this kind of loan is lower than that of an actual personal loan, as the bank has a security against the mutual fund loan. However, the amount that a person is eligible for such a loan as well as the amount of interest is decided entirely by:
The type of mutual fund: For an equity fund, the amount the investor can borrow is usually up to only 50% of the value of the investment, with the interest being around 10%-12%. For debt funds, the investor can borrow up to 70%-80% of the total investment value. The interest on this loan can range (on an average) from 8%-10%.
The financial institution: Even though there is a general range of interest rates, every organization has a rate based on their policy and expertise. So, the rates will vary from place to place.
Market conditions: Mutual funds are a market linked investment. And there are times when the market is peaking and there are times when it is slipping. Accordingly, the value of your portfolio and your mutual funds units also gets affected. Because of that, how the market is doing has an impact on the interest rates the banks offer. They may be slightly higher if the market is down and may go down when the market ascends again.
Can I take a loan against my SIP ?
In most cases, an individual can take a loan on even their SIP investment. However, that may change based on the institution you are applying for the loan at. Some financial organizations only issue loans on certain mutual funds or investments. In such a case, it is best to check the terms and conditions of the loan with the respective bank.
Can I withdraw a small amount from a mutual fund ?
Most open-ended mutual funds have the option for the investor to redeem the funds, either fully or partially, whenever they feel the need to do so. But, doing it before the investment goal is reached is not recommended. Which is why a loan against mutual funds is an option you can choose instead of withdrawing any amount from the mutual fund before your financial goal is reached.
Which mutual fund can be used as collateral ?
A loan can be availed against any mutual fund. However, it is important to check with the financial institution of your choice as to which mutual funds they provide a loan against. This is because certain institutions have a policy of only providing a loan against certain mutual funds or certain types of mutual funds. Which funds can be used as a collateral and which one can’t entirely depends upon the financial institution. For example, branches of SBI only issue loans against units from SBI Mutual Funds. Other institutions like HDFC bank are also selective. Check with your institution which mutual funds they provide a loan against.
How to pledge mutual funds for loans ?
To pledge mutual funds for a loan, a letter or a form needs to be written/filled to either the fund house, or the registrar, mentioning certain details of the holdings and the loan. The fund house will then provide the applicant with the confirmation. The details to be mentioned in the letter are:
1. Name of investor (as mentioned in the mutual fund records)
2. The folio number
3. Name of the scheme
4. Number of total holdings in the scheme
5. Number of units to be pledged as lien
In case of a joint holding in the mutual fund, the letter requires the signatures of all the co-owners in the fund.
Is there a limit to the loan I can be granted ?
Every institution has a set limit for the minimum and the maximum amount that can be granted as a loan against mutual funds or other investments. For smaller corporations, both amounts are smaller. However, the limits for bigger corporations can even go into crores.
For example, most large private banks have a minimum limit of Rs. 50,000 and maximum limit of up to Rs. 20 lakhs for equity mutual funds and up to Rs. 1 crore for debt mutual funds. Other organizations like NBFCs, though, have a much higher limit. Aditya Birla Capital, for example, has a minimum limit of Rs. 25 lakhs and an upper of up to Rs. 10 crores.
The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.
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